INVESTOR APPETITE FOR INDIA RETURNING BUT GOVT BETTER NOT

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TAGS: ECON EFIN EINV ETRD EAGR PREL PGOV PTER IN
SUBJECT: INVESTOR APPETITE FOR INDIA RETURNING BUT GOVT BETTER NOT
DISAPPOINT

REF: NEW DELHI 1162


1. (SBU) Summary. Econoff and ConGenoffs met with Mumbai contacts
on June 1 and 2 to gauge investor reaction to the elections and
signs of recovery in the Indian economy. In contrast to reports at
the beginning of 2009 that investors were waiting for political
uncertainty to end with the May elections, contacts noted that
investors have a "lot of money on the table" for foreign investment
and India and China increasingly stand out among emerging market
destinations. However, market observers and fund managers also
cautioned that the recent rise in the bellwether Sensex stock index
since elections has built in expectations of improved government
performance and service delivery. If those heightened expectations
are not met by the end of the year, contacts warned that the markets
could retreat and foreign investors could rethink their currently
bullish perspective on India. In the meantime, new GDP data
(reftel) provided upbeat news, with the fiscal year that ended in
March growing 6.7%, above expectations, raising some economists'
outlook for the coming year.
Elections Have Improved Sentiment
But Not Fundamentals
--------------


2. (SBU) Several investors pointed to the election results as the
reason for the recent runup in the Bombay Stock Exchange, especially
as tracked by the benchmark Sensex, which has risen more than 2000
points since the parliamentary election results were announced May

16. Krishnakumar G., Managing Partner, IL&FS Investment Managers
Ltd., opined that market investors have perceived that the large
gain in Congress seats will create a stable and solid coalition
government absent the Left and inordinate influence by the regional
parties. The Prime Minister's apparent firmness in limiting
requested ministerial positions to one of the coalition partners who
has underperformed was also well received. Similarly, Sreekumar
Chatra of Macquarie Capital called it a decisive election.
Blackstone Advisors India's Chairman and Managing Director, Akhil
Gupta, went even further, seeing the election results as a "huge
inflection point" for the country, where voters chose performance.


3. (SBU) Reflecting this outlook, institutional investors have
raised their profile in India since the elections. Chatra estimated
$2 billion had entered the country in the last two months in
qualified institutional placements (QIPs),a highly liquid kind of
equity purchase only permitted by stable, experienced funds like
pension funds. Sanjay Agarwal of Bank of America's Investment
Banking Group noted that $5 billion came in foreign institutional
investment (FII) flows in April and May, with $1 billion alone in
the week after election results were announced. This was in sharp
contrast to the previous fiscal year, where FIIs withdrew a net $10
billion. He also saw a substantial amount coming in the form of
QIPs and expected that to continue in at least the short term.

4. (SBU) Contacts noted, however, that although sentiment has
improved, India's fundamentals remain the same as several months
ago, leaving in place several key constraints, especially governance
and infrastructure. Vivek Kudva, President, Franklin Templeton
Asset Management, claimed there was no rationale for the Sensex
rise, as India still has issues. He pointed to poorly targeted
subsidies, lack of "world class" infrastructure and the dampening
effects of the global economic slowdown on India via the export
channel. Blackstone's Gupta assessed the gap between India's
potential and actual achievements as that of governance. He pointed
to weakness in India's courts, where millions of cases are stuck, to
poorly trained and incentivized police, and even to Parliament.
However, the election results have made him very bullish and he
anticipated political stability for at least the next ten years, and
more stability than China.
5) (SBU) On infrastructure, Macquarie's Chatra anticipated there
was $6-9 billion in international infrastructure funds ready to come
into India, if the government could fix the project finance
structures. He zeroed in on necessary amendments to the concession
agreements the government offered to infrastructure developers,
noting that the definition of total project cost was not viable, nor
the bar on cross-holdings which disqualifies otherwise experienced
developers. He viewed Kamal Nath's assignment to the Roads and
Surface Transport Ministry as a positive step, given Nath's
reputation for "efficiency and effectiveness." Overall, he thought

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infrastructure ministries were looking strong. Shubhada Rao of Yes
Bank said there was global interest in investing in India's
infrastructure sector. She thought investors were "piqued by"
government signals since elections, but that they needed to be
confident of the policy framework and were looking for stability
there.
Government Better Deliver
--------------


6. (SBU) Several interlocutors assessed that the markets have
factored in expectations that a lot more will get done in this
Parliamentary session than in 2004-2009. As such, many expressed
the view that the government has 6-12 months to demonstrate
progress, or else euphoria will turn to frustration and possible
capital outflows. Vivek Kudva, President, Franklin Templeton Asset
Management, does see a window now to push through reform, in the
areas of tax and subsidy rationalization that could boost revenues
and more effectively spend existing government funds. JP Morgan
India Chief Economist Jahangir Aziz also saw a risk to sustained
market levels if expectations are not met by December. Besides the
strengthened position of the Congress party and the coalition, Aziz
perceived that the Prime Minister, Finance Minister Mukherjee,
Planning Commission Deputy Chairman Montek Singh Ahluwalia, and even
Home Minister Chidambaram were nursing bruised egos because of their
inability to deliver significant reforms before. This, according to
Aziz, had increased their determination to achieve their goals, as
it was probably the last chance for most of them, given their age.


7. (SBU) Others were more worried about the government's ability to
deliver. Bank of America's Agarwal speculated that the West Bengal
coalition partner, the Trinamool Congress, might act like the Left
parties in blocking reform, while Kudva wryly noted that the
ministerial assignments were encouraging, and they were a "good lot"
of ministers, but they were also "the same lot" that was in the last
government. Madhav Bhatkuly, Director of New Horizons Investments,
also worried that corruption remained a serious impediment to
effective governance and service delivery. Yes Bank's Chief
Economist, Shubhada Rao stated that she had upgraded India's
economic outlook after the elections. But she cautioned that the
Congress party still needs to build consensus on reforms, even
within the party, claiming that the government had "no other choice
but to perform." However, she was upbeat about new Finance Minister
Mukherjee, describing him as open to reason, candid and honest.
Government Borrowing Problematic
--------------


8. (SBU) Kudva pointed out that government yields have risen since
the elections, anticipating significant government borrowing to
address a large fiscal deficit. Macquarie's Chatra looked to
University of Chicago economist Raghuraman Rajan's assessment that
there was not much additional impact to be gained from further
monetary and fiscal stimulus. Deosthalee of Larsen and Toubro and
Bank of America's Agarwal felt it was imperative that the government
get its "fiscal house in order". The markets need clear signals
from the government on its borrowing plans, they said, since the
huge deficit suggests heavy borrowing in the months ahead.
Deosthalee saw that just the anticipation of the government's needed
borrowing has already created upwards pressure on government yields.
Agarwal anticipated that the large size of the council of ministers
would make it harder to rein in expenditures, since there would be
more demands for funding. Yes Bank's Rao noted that the central
bank was signaling the end of its loose monetary policy and that
crowding out had not yet happened because of subdued domestic
corporate demand, implying crowding out could become a problem in
the near future as the economy improved.

Economic Outlook
--------------


9. (SBU) Franklin Templeton's Kudva is skeptical that the Indian
economy is yet out of the woods, feeling that the government salary
raises last year under the Pay Commission artificially and only
temporarily boosted consumer power. Krishnakumar observed that sea
freight container traffic to India is still about half of what it
was at its height in 2008, so that port activity and road traffic is
still lower than some investors find attractive. He expects another

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year or two before traffic recovers. JP Morgan's Aziz does not
think there is sufficient domestic demand to sustain higher economic
growth beyond 6-12 months. He thinks the decent GDP growth rates of
the last six months have come from government workers spending more
from their Sixth Pay Commission salary increases, which will not
sustain growth, a view echoed by New Horizons' Bhatkuly. Aziz
anticipated that, by the second half of 2010, India will need the
global economy to recover and boost exports in order for its GDP to
sustain growth above 7 percent. Some interlocutors, though, were
more upbeat. Macquarie's Chatra said that his firm had raised its
India GDP projection for FY10 after the elections to 7%. Likewise,
Yes Bank's Rao noted her upward bias on a 6% growth projection,
saying she needed a "clearer picture of agriculture" before raising
the projection. She expected Indian company expansion plans to go
slowly, as global demand was key to many of the expansion
projections.

Investment Outlook
--------------


10. (SBU) IL&FS' Krishnakumar said that in his recent roadshow
meetings with several hundred European investors, he saw a focus on
India and China as the only two countries still growing. As such,
whether India's growth rate was 6% or 7% was of lesser concern,
since no other country besides China was close to that kind of
growth rate. While investors are re-examining emerging markets
after 9 months, Krishnakumar also noted that the economic slowdown
is generating new opportunities in Canada and Europe with rare,
attractive 8-10% returns, noting that country risk in India requires
20-25% returns. When asked if India was rising in investor
estimation given its current higher growth, Agarwal temporized,
placing India as a new "star" in emerging markets portfolios, but
not breaking free from that category. Agarwal looked to the third
quarter of 2009 for capital markets to really open for the US,
followed by Europe, then lastly by emerging markets.


11. (SBU) Kudva still does not yet see long term funds coming into
the markets. Agarwal also noted the lack of medium and long term
financing, seeing only 2-3 year short-term money available in the
market right now. He noted this is especially detrimental for
infrastructure financing, which needs such long-term financing to
match the 10-20 year gestation period of projects. Agarwal
estimated that banks have put $20-25 billion in mutual funds in the
last few months, rather than on-lend, because of concerns over
credit quality. Larsen & Toubro's Chief Financial Officer, Y
Deosthalee, echoed that, lamenting that long term project finance in
the West has not yet adequately improved. He acknowledged that
availability has increased somewhat but affordability of foreign
financing is still a problem. Deosthalee pointed to the
government-administered high-interest savings schemes that capture
much of long-term savings, preventing them from becoming long term
lending instruments. For Gupta of Blackstone as well as Yes Bank's
Rao, they saw the Budget, expected in July, as a major signal to
investors of government priorities, including how to handle the
budget deficit.

Comment
--------------


12. (SBU) Economists and investors in Mumbai had mixed views on
whether the economy was yet recovering, but most agreed that the
next six months were critical for the government to signal ability,
not just intent, to achieve policy goals. There was general
agreement that the markets had risen too quickly and priced in
performance, adding pressure to the government's need to demonstrate
policy success or else see a retreat in foreign institutional
investment. The election results had removed a major uncertainty to
investors, but many seemed unwilling to more fully commit funds
until the policy framework was made clearer. The government's
stated priority for infrastructure development requires significant
private (read foreign) investment and so the ball is now solidly in
its court to convince foreign investors who stand poised to commit
billions to India's future.


13. (U) Mumbai contributed to this cable.


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